Inflation Appears To Be Setting The Tone For Stocks Going Forward

Nike NKE was trading down 5% in pre-market action after reporting lower than expected revenues last quarter and slashed its revenue projections. The company cited high demand for its athletic gear, but the broken supply chain is giving Nike issues in Vietnam and Indonesia. However, chemical company H. B. Fuller FUL traded 2% higher in pre-market trading on better than expected revenues. Costco COST also traded higher before the open with better-than-expected revenues but warned that inflation, higher labor costs, higher freight and transportation costs, and supply chain delays could slow them down.

Fed members including Chair Jerome Powell are hitting the speaker circuit on Friday. Investors will likely listen in for more clues on the taper timeline. August's new home sales will report after the opening. It’s likely that the report will be similar to the building permits report earlier in the week, indicating higher demand but an inability to get construction supplies.  

Stocks rallied on Thursday without the leadership of the FAANG stocks. Instead, upbeat guidance from Accenture ACN, Darden Restaurants DRI, and Salesforce.com CRM appeared to help lead the charge.

Energy stocks provided a lift too. The Energy Select Sector Index ($IXE) was the top group rising about 3.5% in response to a 1.2% rally in oil prices (/CL). Exxon XOM and Chevron CVX were among the leaders in the sector.  

Rising oil in the wake of the Fed’s more hawkish stance pushed the 10-Year Treasury Index (TNX) up more than 5.5%. Rising yields helped spark a rally in the Financial Select Sector Index ($IXM) which includes companies like Citigroup C, Bank of America BAC and JPMorgan Chase JPM were among the financial top performers.

The bulls were able to make some technical gains. The S&P 500 (SPX) filled Monday’s gap down and reclaim the 50-day moving average. Apparently, “buy the dip” is not dead yet. Fed Chair Jerome Powell appears to have been just hawkish enough for bond traders but accommodative enough for stock traders. The Fed’s messaging, the low likelihood of contagion with Evergrande’s debt issues, and downtrending jobless claims seem to be giving the bulls are reason to charge.

The Fed And Inflation

The market began charging higher even before Wednesday’s Fed meeting and has continued to gain pretty much since then as investors contemplated a possible near-term taper of the Fed’s stimulus. A taper would likely be welcomed by some investors, who might see it as evidence of the Fed finally fighting against troubling inflation growth.

Looking back at Powell’s press conference Wednesday, it sounds like he thinks the inflation is due to reopening bottlenecks and will slow next year. The market isn’t necessarily convinced, however. Having said that, it was reassuring to see the Fed raise its 2021 inflation forecast to take current price pressures into account. You’d like to think the Fed is taking notice of an issue that’s really hurting a lot of companies out there.

One question is how long the Fed’s taper program might last once it starts. There’s talk on the Street that it could be executed a bit more quickly than back in 2013, the last time this happened. Powell reinforced that idea by saying in his press conference that the economy is in much better shape now than it was in 2013.

Powell also said a taper announcement doesn’t necessarily signal a rate hike, and that the economic bar is much higher for hiking than for tapering. What the rate hike “bar” might be is still a little fuzzy.

Decent Or Not Decent? It’s Subjective

Powell (who’s scheduled to make opening remarks Friday in a webcast event focused on the pandemic recovery) also said he’d like to see a “decent” September jobs report from the Department of Labor as he and others at the Fed contemplate when to taper. This brings up the question of what’s “decent” in terms of jobs growth.

The economy has created an average of 750,000 jobs a month over the last three months, but that fell below 300,000 in August due in part to the Delta variant and its impact on the travel and leisure sectors. However, even 200,000 new jobs created in a month were considered the standard of excellence before the Covid shutdown and reopening.

What’s decent now might be in the eye of the beholder, but let’s imagine it would have to be at least in the ballpark of the 235,000 jobs created in September, and maybe higher than that. Only Powell really knows.

CHART OF THE DAY: TREND BREAK. The Communications Services Select Sector Index ($IXC—candlestick) recently broke its upward trendline. Its relative strength indicator recent broke a support level that some technical analysts see as a sign the group may underperform the S&P 500 in the near term. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results. 

A Breakdown In Communication: When the price of security breaks below its trendline, it’s not necessarily a bearish sign. It could be a sign that the security will move sideways for a while. It makes sense that investors would be looking to take some profits and rebalance their portfolios if the growth has caused the sector to become a larger part of a portfolio.

Telecoms’ close relation to tech helps tie their fates together on some level. Like tech, the Communications sector has performed well because it was central to personal and business survival during COVID lockdowns. The slow progress back to “normal” lessens some of the reliance on these sectors.

Inflating Earnings Revisions: Charts aren’t the only way to identify changes in a sector’s strength, earnings revisions are also helpful. A big driver of a stock’s price is not just earnings forecasts but earnings revisions. A revision occurs when analysts feel that their previous earnings estimate is too high or too low. Positive revisions occur when the analyst is projecting better than expected earnings. Many fundamental analysts track positive revisions to find stocks that have the potential to grow in the short term.

FactSet observed that the term “inflation” was cited a record 224 times during second-quarter earnings calls for S&P 500 companies. So far, rising inflation hasn’t been a problem for many companies because they’ve been able to pass off the additional costs to consumers. Earnings estimates are currently projected to be higher in nine of the 11 sectors. By monitoring earnings estimates revisions, investors may be alerted to changes that inflation may have on a company’s profits.

About The Benjamins: The spike in the 10-year Treasury yield took the rate up to 1.41% breaking a short-term resistance level at 1.375%. If the breakout is sustained, rates could continue higher for the 10-year yield and across the yield curve. Higher Treasury yields tend to attract yield-seeking investors to the U.S. which normally strengthens the dollar.

A stronger dollar is complex. Generally, it increases the consumer’s buying power and helps to combat inflation. It makes imports cheaper, but exports more expensive. Most of these effects will take time to develop.

But the strength of the dollar will also differ compared to the strength of other currencies. For example, early this month when the European Central Bank announced a “mini-taper”, the euro appreciated against the dollar for a couple of days. So, if other central banks taper or tighten, the currencies will change accordingly.

So, keep these complexities in mind when you’re attempting to digest the news. Some will claim the strong dollar will be bad and some will claim it’ll be good. In the end, it depends. 

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Image by 995645 from Pixabay